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You can use a HELOC for leveraged investing. But what happens if you sell your home and want to maintain the tax deductibility of your interest costs?
I’m planning to sell my principal residence, a condo in downtown Toronto. I don’t have a mortgage on the property, but I do have a sizable HELOC. I borrowed several thousand dollars to invest in equities and have been deducting the interest costs at tax time. My lender says I will have to pay off and close the HELOC upon selling the condo, since it’s tied to the property. What should I keep in mind with respect to my leveraged investing? I’d like to keep deducting the interest, going forward.
—Jackie
I have ideas on your leveraging, Jackie, but first I want to give some background—as well as a warning—for the benefit of other readers, too.
Borrowing to invest can be risky. It can magnify your returns, as well as your losses. The best candidate for leveraged investing is someone with a high risk tolerance, a long time horizon and low investment fees.
Leveraged investing for the short term can be risky, because stock prices can fall several years in a row, even if they rise most of the time.
If you’re a balanced investor buying stocks and bonds, particularly if you pay high investment fees, it can be hard to earn a profit over and above the interest costs.
You can deduct interest on money that you borrow for investment purposes if the investments are taxable. So, you cannot deduct interest on money borrowed to invest in a registered retirement savings plan (RRSP) or tax-free savings account (TFSA).
When you borrow money to invest in stocks, you can deduct the interest on line 22100 of your personal T1 tax return. You can also deduct other expenses or carrying charges on this line, such as fees for investment management or for certain investment advice, or accounting fees if you have income from a business or property.
If your investments produce only capital gains, you cannot deduct your interest. If you are in Quebec, you may be limited provincially from deducting interest that exceeds your investment income for the year.
HELOC stands for home equity line of credit, a type of loan secured by your home—meaning that your home is collateral for the loan. HELOCs provide revolving credit, so you can borrow money as you need it, up to a certain amount—usually a percentage of the value of your home. Most HELOCS have no fixed repayment schedule, although you will have to pay interest monthly. In contrast, a home equity loan is a lump sum with a fixed repayment schedule for the full amount.
Read the full definition in the MoneySense Glossary: What is a HELOC?
You mentioned you borrowed using a home equity line of credit (HELOC), Jackie. Most HELOCs have interest-only payments, so that ensures your payments are all tax-deductible when you borrow to invest in eligible investments. However, HELOCs tend to have higher interest rates than mortgages.
A typical HELOC rate is the prime rate, plus 0.5% or 1%, whereas a variable-rate mortgage may have a discount to the prime rate of 0.5% to 1%. It may make sense to consider converting a tax-deductible HELOC to a mortgage to reduce your cost of borrowing. This would increase your payments, since mortgage payments include principal and interest, so it might slightly increase your cash-flow requirement. However, paying lower interest may make the leverage more beneficial overall.
If you are moving to a new home that you are buying, Jackie, you could consider porting your HELOC to the new property. This way, the debt can be preserved, as well as the tax deductibility.
Often you can port a mortgage from one property to another, and a HELOC is effectively a mortgage. Your lender may be able to pay off the initial HELOC with a new HELOC secured by the new property, all on the same day.
If you’re going to be renting, one option could be to use an existing unsecured line of credit or apply for a new one. And it could be used to pay off the first line of credit and to maintain your interest deductibility.
Another option: Set up a margin account, if you’re not already holding your investments in one. This account would let you borrow against the investments to pay off the HELOC. Once again, tax deductibility could be maintained.
An unsecured line of credit or margin account would both likely have higher interest rates than your secured HELOC, Jackie.
If you’re going to be renting for a period of time, or your closing dates for the sale and purchase of properties don’t match up, you won’t be able to just set up a new line of credit for the same amount in the future and begin deducting interest. You would once again need to tie the borrowing to investing. You could sell investments and use a new HELOC to borrow back and replenish the investment account, though.
You can borrow money and invest it in a non-registered investment account and deduct the interest. To increase your odds of coming out ahead, try to reduce your interest rate as much as possible and invest in a low-cost equity portfolio for the long run.
For what it’s worth, most Canadian investors don’t borrow to invest. If you do, try to tilt things in your favour.
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